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5 Quality ETFs and Stocks for Outperformance

The stock market has been exhibiting volatility in the past few weeks. While geopolitical tensions, renewed fears over the implementation of President Donald Trump’s pro-growth agenda, an uncertain Fed policy and high stock valuations are weighing on the stocks, strong corporate earnings, and improving health of economies around the world act as tailwinds.

This is especially true as the economy has been on a solid growth path buoyed by an impressive labor market, increase in wages, and higher consumer spending. U.S. GDP growth expanded 2.6% annually in the second quarter, which is double the first-quarter growth of 1.2% and represents the fastest growth since the third quarter of last year, when the economy grew 2.8%.

Consumers also appear to be more optimistic with the University of Michigan’s consumer sentiment rising to the highest level since January, reflecting confidence in the outlook for the economy. Further, retail sales recorded the biggest increase in seven months in July (read: Retail Sales Off to a Great Start to Q3: ETFs to Buy).

Given improving economic fundamentals and heightened uncertainty, investors should focus on high-quality investing through a basket form.

Why Quality Investing?

Quality stocks are rich in value characteristics with healthy balance sheets, high return on capital, low volatility, elevated margins, and a track of stable or rising sales and earnings growth. These stocks thus reduce volatility when compared to plain vanilla funds and hold up rather well during market swings. Further, academic research shows that high-quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term.

Given this, we have highlighted five solid picks each from the ETF and stock worlds, targeting this niche strategy. Any of these could enjoy smooth trading and outperform the U.S. market in the coming months.

This fund provides exposure to stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth, and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index. Holding 125 securities in its basket, it is moderately concentrated across sectors with each holding less than 6.3% share. Information technology, financials and healthcare are the top three sectors. The product has amassed $3.4 billion in its asset base and charges just 15 bps in annual fees from investors.

This fund tracks the S S&P 500 Quality Index, a benchmark of S&P 500 stocks that have the highest quality score based on three fundamental measures: return on equity, accruals ratio and financial leverage ratio. This approach has resulted in a basket of 99 stocks with each holding less than 5.3% of total assets. The fund is skewed toward industrials at 22.4%, followed by information technology (18.2%), consumer discretionary (16.5%) and consumer staples (15.2%). It has managed $1.3 billion in AUM and charges 29 bps in annual fees (read: Blue Chips to Soar Ahead? Buy These 5 ETFs).

This ETF seeks to track the performance of the rules-based and fundamentals-driven Barron’s 400 Index. The benchmark uses the MarketGrader's fundamental analysis to select America’s highest-performing stocks based on growth, valuation, profitability and cash flow. It holds 399 stocks in its basket with each accounting for less than 1.1% share. Information technology, consumer discretionary, financials, healthcare and industrial are the top five sectors with double-digit exposure each. BFOR has lower AUM of $195.1 million and a higher expense ratio of 0.65%.

This ETF follows the Northern Trust Quality Dividend Index and seeks to maximize exposure to quality and dividends while maintaining a beta near 1. In total, it holds 146 securities with each accounting for less than 3.3% share. Information technology, financials, industrials, consumer staples and healthcare are the top five sectors with double-digit exposure each. QDF is popular with AUM of $1.7 billion and has an expense ratio of 0.37% (read: 5 Cheap Dividend ETFs for an Uncertain Market).

This fund offers exposure to stocks that have a combination of value, low volatility and quality factor strategies. This is done by tracking the MSCI USA Factor Mix A-Series Index. Holding 634 stocks, the fund is widely spread out across components, with none holding more than 2.8% share. It is tilted toward the information technology sector as it accounts for one-fourth of the portfolio while healthcare, financials, consumer discretionary, and consumer staples round off the top five. The fund charges 15 bps in fees per year and has amassed $67 million in its asset base.

Stock Picks

To find out the best stocks in this space, we have used the Zacks stock screener. The parameters include Zacks Rank #1 (Strong Buy) or 2 (Buy), VGM Score of A or B, return on equity (ROE) of at least 10%, debt-to-equity ratio of less than 1, positive 5-year historical EPS growth, positive current-year EPS growth, positive current-year earnings estimate revisions over the past 30 days, and dividend yield of greater than 1%.

This Indiana-based company is one of the leading worldwide designers and manufacturers of diesel engines. It has seen solid earnings estimate revision of 29 cents for this year over the past 30 days with an expected earnings growth rate of 17.65%, much higher than the five-year historical average of 10%.

This Canada-based company is engaged in providing financial protection products and investment management services to individuals, families, businesses and groups in selected international markets. The company flaunts a track of above-average earnings growth of 35.1% over the past five years. This trend is likely to continue with an expected 20.18% earnings growth for this year. The stock has seen solid earnings estimate revision of 14 cents over the past 30 days for this year.

From a balance sheet perspective, Manulife Financial has lower debt with a debt-to-equity ratio of 0.14 while ROE is 11.33%. Additionally, it yields 3.01% in annual dividend. The stock has a Zacks Rank #2 with a VGM Score of A. It belongs to a solid Zacks Industry Rank in the top 8%.

This Florida-based company manufactures and sells a wide range of uniforms, corporate I.D., career apparel and accessories for the hospital and healthcare fields; hotels; fast food and other restaurants; and public safety, industrial, transportation and commercial markets, as well as corporate and resort embroidered sportswear. It has a good track of 31.15% earnings growth over the past five years and expects to grow 27.17% year over year this year. Earnings estimate revisions for the current year has gone up by two cents over the past 30 days.

The company’s debt-to-equity ratio of 0.29 and ROE of 11.51% is also good. The company has 1.73% in annual dividend yield. The stock has a Zacks Rank #2 and a VGM Score of A. The Zacks Industry Rank in the top 7% is superb.

This California-based company designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits. The company’s earnings growth was a stellar 38.63% over the past five years and is expected at 27.82% year over year for the current fiscal year. The company has seen a whopping earnings estimate revision of $1.65 for the fiscal year over the past 30 days.

This California-based company is one of the world's largest semiconductor chip maker. It has seen positive earnings estimate revisions of 14 cents over the past one month with an expected growth rate of 10.18% for this year. The company has grown 8.5% over the past five years and ROE and debt-to-equity ratio currently stand at 18.63% and 0.41, respectively.

The stock yields 3.1% in annual dividend and belongs to a solid Industry Rank in the top 2%. INTC has a Zacks Rank # 2 and a VGM Score of A.

In Conclusion

Quality ETFs and stocks often provide hedge against market volatility, which has increased due to geopolitical tensions and doubts over the implementation of Trump’s pro-growth agenda. Adding any of the above-mentioned products to one’s long-term portfolio could be worthwhile thanks to their credit worthiness and soundness.

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